Iraqi Child

Promises but no plan for Iraq's reconstruction


By Alan Beattie

Published: March 27 2003 21:28 | Last Updated: March 27 2003 21:28


With every bomb that falls on Iraq, the task of rebuilding its already-ravaged economy becomes greater. Yet as soon as the fighting ends, putting the oil-rich country on a self-sustaining path will be essential to establishing it as a beacon of prosperity and stability in the Arab world.

The trouble is, western governments and international institutions appear to lack both a detailed knowledge of the scale of Iraq's economic disintegration and a strategy to reverse it.


The money trail
As the US scrambles to find funds to rebuild Iraq after the war, there is a tantalising pot of money that government investigators believe may be squirreled away in bank accounts and investments around the world.



The last International Monetary Fund assessment was carried out 20 years ago; the World Bank stopped lending fresh money in 1973, ironically because oil income had made Iraq too wealthy to be eligible. This did not prevent Iraq subsequently making itself a pariah state in international finance by defaulting to the World Bank and other external creditors, though Baghdad was swift to sue Uganda when that country tried to write down its own external debt during the 1990s.




It is, however, all too obvious that the huge opportunity offered by higher oil prices during the 1970s has been squandered. The last IMF assessment, conducted in 1983 and obtained by the FT, paints a disturbing picture of an economy already coming apart under the strains of the Iran-Iraq war. The boom in oil earnings in the late 1970s paid for foreign contractors to build infrastructure, helped to diversify the economy and raised living standards. But these gains were reversed by the cost of the long war with Iran and the disruption to oil exports. This "necessitated the adoption of an austerity programme and a rationalisation of the development effort", the IMF ominously concluded.

Since then, capricious and corrupt government and sanctions imposed after the invasion of Kuwait mean that per capita income is reckoned to have shrunk by at least two-thirds. Life expectancy, food production and literacy rates have stagnated or declined.

Estimates by the Economist Intelligence Unit (EIU) suggest the size of the Iraqi economy is currently around $28bn a year. Of this, $15bn-$16bn is accounted for by oil exports whose proceeds are distributed to the population under the oil-for-food programme. The EIU reckons that oil smuggling brings in another couple of billion dollars to selected friends of the regime.























The key to reconstruction will be to restore and boost oil production, in order to earn enough dollars to feed the population while creating some surplus to contribute towards investment. But even without wartime sabotage, academics estimate that several years' work and about $5bn in investment will be needed to raise Iraqi production from its current output of around 2.5m barrels a day back to its pre-1991 level of 3.5m b/d.

Anthony Cordesman, who holds a chair in strategy at the Centre for Strategic and International Studies think-tank in Washington, says the short-term potential for oil has been heavily overplayed. "A command economy with a failed agricultural sector, no real investment since 1982 and no effective banking system has to be completely restructured," he says. "There is no way in hell oil can solve all Iraq's problems."





















In the short term, the challenges of restarting the shattered economy could dwarf the contribution of oil. For one, Iraq faces enormous external obligations which, left unaltered, could wreck any attempt to refloat the economy.

A CSIS study reckons that claims under a United Nations-run reparations programme instituted after the 1991 Gulf war, largely to compensate Kuwaitis, total up to $320bn. These payments currently cream off 25 per cent of Iraq's oil earnings. On top of this, Iraq's crushing external debt is estimated to be anywhere between $62bn-$130bn, two to four times the size of the economy, largely owed to other Middle Eastern states. Iraq also has pending contracts, mainly with Russian companies, which are estimated at $57bn. Without a massive reduction in these liabilities, Iraq is insolvent however quickly oil production can be increased; its people will not see the benefit for decades. "Divide all that [debt] by current oil earnings and most Iraqis would be dead before they got anything," Mr Cordesman says.

Rubar Sandi, a Washington businessman and head of the US-Iraq Business Council, who has been advising the US administration on its reconstruction plans, lays out a potential route towards sustainable growth. If oil production can earn $20bn in the first year, he says, ending reparations payments and writing down debt would leave $11bn a year for government services - largely humanitarian aid - and $9bn for investment in Iraq's tattered infrastructure. This would provide most of the investment he estimates is needed immediately after the war, with international donors or private investors making up the rest. He says that oil production capacity should aim to more than double to 6m b/d in four years.




Other estimates are less optimistic. They suggest that oil will contribute no more than $4bn a year to investment in the first couple of years, placing much more of the onus on foreign aid.

Another problem will be revamping Iraq's primitive and decayed financial system. The newer "Saddam dinars" that circulate in most of the country are printed at will by the politically controlled central bank to finance government spending. In 1983, the Iraqi dinar was worth more than three dollars. Now, various estimates put the black market rate at between 2,200-2,700 dinars per dollar, having worsened sharply from about 1,700 over the past few months.

Inflation is estimated at 60-100 per cent. The few state-owned banks offer interest rates well below this, so most of the country runs on a cash economy and often resorts to dollars. Only in the Kurdish north, where the population retains the earlier "Swiss dinar", the fixed supply of which controls inflation, is there anything resembling macroeconomic stability. One early priority is the tricky judgment of uniting the two currencies without making half the country uncompetitive, forcing rapid adjustments through more inflation or destabilising mass internal migration.




In this regard, reconstructing a monetary system in Iraq is not unlike the challenges faced in Afghanistan. There, the old Afghani currency, subject to widespread counterfeiting and competing with at least one rival currency issued by a local warlord, had to be replaced with another. The exchange, though posing tricky logistical and security problems, has at least resulted in a single currency circulating in the country.

A senior IMF official involved in Afghan reconstruction recounts how an initial burst of inflation as the new currency was introduced, and many locals rushing to change their currency into dollars, has now come under control. But he does not underestimate the difficulty of re-establishing a monetary system in a country that has lived under informal and cash systems for so long. "The Afghans are now hoping that one or two foreign banks will set up," the official says. "But the central bank lacks the capacity to supervise banks or run anything but the most basic monetary system."

Indeed, there are deeper lessons from the recent experience of postwar economic reconstruction - in Bosnia and Kosovo as well as Afghanistan. Piecemeal moves towards reforming an economy, particularly in the absence of a functioning state apparatus, often break down. Building new roads and pipelines will not create a flourishing and diverse economy in the absence of a trustworthy and functioning financial system.




True, the deep underlying potential for Iraq is brighter than for economies such as Afghanistan. Iraq has a long, though recently interrupted, history of learning and literacy. And, as can be seen from the flourishing economy in the Kurdish north, outside Mr Hussein's control, a strong trading and entrepreneurial tradition endures. Textile factories, food-processing plants and internet cafes have all sprung up in the Kurdish areas, where an engineer can earn $80-$120 a month compared with $50 in the rest of Iraq.

"The Iraqi education system used to be the best in the Middle East," says James Reeve, an analyst at the EIU. "Take away the corrupt leaders and the potential for the Iraqi economy is good."

But breaking into a virtuous circle of growth and development which can release the potential of Iraq's population will require a multi-faceted solution to the country's problems. "Any plan has to be comprehensive and deal with all the problems of the Iraqi economy," Mr Sandi says.




Such a strategy has yet to emerge. The international agencies with expertise in economic reconstruction have yet to form themselves into a coherent taskforce. The IMF has quietly set up a working group on Iraq but it is at the stage of abstract discussion rather than practical planning. The World Bank and United Nations, too, are loath to risk accusations of political bias by starting on grandiose Iraq reconstruction plans before the end of the war.

The onus for planning economic reconstruction for the moment thus falls largely to the US. But, following meetings with officials from the Commerce Department, Treasury and National Security Council, Mr Sandi remains unconvinced they grasp the gravity of the country's interlocking economic problems. "The plan is not yet there," he says. "We need to have a single co-ordinated agency." The US Treasury is concerning itself mainly with resolving the currency problem, while USAID, which comes under overall control of the State Department, is handing out reconstruction contracts, and the Commerce Department and the Pentagon are also involved. US officials reply that they are co-ordinating with each other, and that each department is sticking to its area of expertise.

The Iraqis had better hope that a co-ordinated reconstruction plan with broad political backing rapidly appears. If not, their battered economy will struggle to do much more than feed its people, never mind reverse 20 years of neglect.


Additional reporting by Peronet Despeignes